Advise a client to turn down an inheritance? Well, maybe...
Surprisingly, you may want to advise a client to refuse an inheritance. Example: A client who expects to receive assets from an elderly parent might prefer that the funds go directly to his or her children.
Strategy: Have the client use a "qualified disclaimer." Assuming it contains the necessary legal paperwork, the inheritance bypasses the client's estate. Thus, the family can lower its overall estate tax bill. Similarly, a disclaimer may save federal estate tax when a spouse passes away (see Example below).
Details: A qualified disclaimer is a written, irrevocable decision by an estate's beneficiary to refuse all or part of a bequest. The beneficiary must make the disclaimer within nine months of the decedent's death and before he or she receives the property.
Currently, up to $2 million can pass to a non-spouse beneficiary free of estate tax. This estate-tax exemption is scheduled to increase to $3.5 million in 2009.
Even better: The federal estate tax disappears completely in 2010. But, unless Congress amends the law, the estate tax will be revived in 2011 with a tax exemption shelter of only $1 million. So estate planning remains a concern.
Estate planning dilemma: When someone receives an inheritance from a parent, any amount above the estate-tax exclusion is subject to tax in the parent's estate. Assuming the beneficiary's children stand to inherit the assets, it's possible the same wealth will get hit with estate tax again.
With a qualified disclaimer, estate tax is due only once when the assets pass straight through to the younger generation. If the estate is worth less than $2 million, no estate tax is due.
Note: Certain transfers that skip a generation - such as direct bequests from a grandparent to a grandchild - are subject to the generation-skipping tax (GST). But a grandparent can claim a generous $2 million GST exemption (for 2007).
Example: Avoid 'marital problems'
Married couple Harry and Wanda Owens own $3 million in assets. They have two adult children. Assume Harry dies in 2007 and leaves his entire estate to Wanda. No federal estate tax bill is due because the entire amount comes under the unlimited marital deduction.
But suppose Wanda dies shortly thereafter. The estate tax exemption equivalent for 2008 is scheduled to remain at $2 million. Thus, $1 million of Wanda's assets will be exposed to estate tax after using the federal tax exemption. The estate tax bill comes to $450,000.
Alternatively, Wanda can disclaim part of the bequest. For instance, if she bypasses $1 million in assets, that amount can be passed to her two children without any estate tax consequences. The transfer is completely sheltered from estate tax by the exemption for Harry's estate.
Reprinted with permission from The Tax Strategist, September 2007. For continuing advice on this and numerous other tax strategies, go to www.TheTaxStrategist.net. Receive 2 FREE Bonus Reports and a 40% discount on The Tax Strategist when you use Promo Code WN0013.